Fonterra Capital Restructuring: Proposed Government Response
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Fonterra Capital Restructuring: Proposed Government Response Proposed amendments to the Dairy Industry Restructuring Act 2001 MPI Discussion Paper No: 2022/03 Prepared for the Ministry for Primary Industries ISBN: 978-1-99-102671-2 (online) ISSN: 2253-3907 (online) April 2022
Disclaimer While every effort has been made to ensure the information in this publication is accurate, the Ministry for Primary Industries does not accept any responsibility or liability for error of fact, omission, interpretation or opinion that may be present, nor for the consequences of any decisions based on this information. This publication is available on the Ministry for Primary Industries website at http://www.mpi.govt.nz/news-and-resources/publications/ © Crown Copyright - Ministry for Primary Industries
Table of Contents
DISCLAIMER II
PURPOSE 1
SUBMISSIONS 1
THE SCOPE OF THIS CONSULTATION 2
BACKGROUND 2
GOVERNMENT RESPONSE 5
NEXT STEPS 11
iPurpose
The Ministry for Primary Industries (MPI) invites comment from interested parties on agreed
amendments to the Dairy Industry Restructuring Act 2001 (DIRA), which comprise the
Government’s response to Fonterra’s capital restructuring.
Submissions
MPI welcomes written submissions on the regulatory measures contained in this document. All
submissions must be received by MPI no later than 5 pm on Friday 3 June 2022.
Submissions should be emailed to: DIRA2022@mpi.govt.nz
We will consider all relevant material made in submissions, so you are welcome to provide
information supporting your comments. Please make sure you include the following information in
your submission:
• the title of this consultation document;
• your name and title;
• your organisation’s name (if you are submitting on behalf of an organisation), and whether
your submission represents the whole organisation or a section of it; and
• your contact details (that is, phone number, address, and email).
Submissions received after 5pm on Friday 3 June 2022 may not be considered.
Submissions are public information
Please note that your submission is public information. Submissions may be the subject of
requests for information under the Official Information Act 1982 (OIA). The OIA specifies that
information is to be made available to requesters unless there are grounds for withholding it, as set
out in the OIA. Submitters may wish to indicate grounds for withholding specific information
contained in their submission, such as if the information is commercially sensitive or if they wish
personal information to be withheld. MPI will take such indications into account when determining
whether or not to release the information.
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 1The scope of this consultation
In scope
1. MPI undertook targeted engagement with some stakeholders in 2021, seeking comment on the
potential benefits, risks, and impacts of Fonterra’s capital restructuring proposals at the time
they were announced. This consultation is focused on the elements of the agreed government
response to Fonterra’s capital restructuring, as announced by the Minister of Agriculture on 27
April 2022. MPI is seeking comment on the regulatory measures outlined below – specifically
your assessment of their effect, implications for your own operations, the wider dairy industry,
and how the broadly described measures below might most effectively be designed and
implemented.
Out of scope
2. This consultation is not seeking comment on:
• Fonterra’s capital restructure.
• Other regulatory or alternative government responses to Fonterra’s capital restructure.
Background
Fonterra intends to change its capital structure
3. In December 2021, Fonterra shareholders voted in favour of a new capital structure to replace
the current Trading Among Farmers (TAF) capital structure, which has been in place since
2012.
4. The key elements of Fonterra’s intended capital restructure1 are:
• A reduction in the minimum shareholding requirement from 1 share for 1 kilogram of
milksolids (kgMS) supplied (1:1) to 1 share for every ~3 kgMS supplied (1:3).
• An increase in the maximum shareholding, from 2 shares for every 1 kgMS supplied (2:1)
to 4 shares for every 1 kgMS supplied (4:1).
• Operating a restricted farmers-only market for future share trading, with a lower (10 rather
than 20 percent) cap on the size of the unit Fund. This involves partially delinking the unit
Fund, so that farmers, the market maker2 and Fonterra will no longer be able to convert
Fonterra shares into units (although existing units could still be converted into shares).
Farmers will instead trade their Fonterra shares in a restricted famers-only market,
supported by the market maker.
5. This marks a substantial shift away from the existing TAF arrangements which comprise:
• The Fonterra Shareholders’ Market, where only farmer-shareholders, the market maker,
and Fonterra can trade Fonterra shares. These shares comprise both wet (compulsory and
voting) and dry (discretionary and non-voting) shares.
1
Full details can be found at https://www.fonterra.com/nz/en/capital-structure/our-choice.html.
2
The market maker is a financial institution contracted by Fonterra to ensure liquidity in the Fonterra Shareholders’ Market through
continuous offering of both buy and sell orders for Fonterra shares. A key role of the market maker is to ensure that the spread between
buy and sell prices is restricted to a narrow range, which is achieved by the market maker participating in the trading of units and
exchanging them for shares, and vice versa.
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 2• The Fonterra Shareholders’ Fund (unit Fund), where farmer-shareholders, the market
maker, Fonterra, and the public (investors) can trade units in economic (non-voting) rights
to shares in Fonterra.
6. In the TAF structure, the Fonterra Shareholders’ Market and the unit Fund are intrinsically
linked, so that farmer-shareholders, the market maker, and Fonterra can convert dry shares to
units and vice versa. This link is an essential element of the TAF structure, as it is the
mechanism for discovering the full underlying (fair) value of Fonterra shares.
Fonterra’s capital structure is regulated
7. In 2001, the Government passed the DIRA to allow Fonterra’s formation by overriding the
merger constraints of the Commerce Act 1986. It permitted the merger of New Zealand’s then
two largest dairy co-operatives (collecting 96 percent of milk production) and the New Zealand
Dairy Board.
8. The creation of Fonterra provided the opportunity for the New Zealand dairy industry to capture
cost efficiencies in collection and processing of farmers’ milk, and to compete at scale
internationally. However, it also created risks. Fonterra’s significant market power gave it
control over most farmers’ milk, thus potentially locking out more innovative or efficient
competitors. Without effective contestability for farmers’ milk, there was a risk that Fonterra
might have fewer incentives to perform, thereby undermining the wider longer-term economic
benefits for which it had been formed. To manage this risk, the DIRA introduced measures to
ensure contestability of milk supply in New Zealand, including measures relating to Fonterra’s
capital structure.
9. Fonterra is free to determine its capital structure with the agreement of its farmer-shareholders.
However, since its passage in 2001, the DIRA has contained provisions to ensure that
Fonterra’s shares are not priced substantially below their full intrinsic worth (fair value) of the
co-operative’s business. This was to ensure that farmers had clear price signals relating to the
performance of their co-operative and to aid their decisions on investment and where to direct
their milk supply.
10. The DIRA originally required Fonterra to issue and redeem shares directly from farmers at an
administratively determined share price. In 2012, at Fonterra’s request, Parliament amended
the DIRA to enable Fonterra to move to the current Trading Among Farmers (TAF) structure.
TAF replaced the original issue and redemption obligation and was supported by the then
Government on the basis that it continued to ensure sufficient liquidity and full fair value price-
discovery for Fonterra shares.
11. The 2012 DIRA amendments enabled Fonterra to introduce TAF to better manage its
redemption risk, so that capital would not need to be diverted from its then business strategy of
growing global milk pools and overseas investments. The 2012 DIRA amendments included a
requirement that the original statutory issue and redemption obligation on Fonterra would be
reinstated if key elements of TAF were removed. This was to safeguard against Fonterra
shares being priced at substantially below their full fair value, should the co-operative’s capital
structure change in the future.
12. If Fonterra’s shares were priced substantially below their full fair value, this would discourage
existing Fonterra farmers from switching supply (whether to an alternative processor or an
alternative land use), as they may not be able to realise the full fair value of their past capital
investment in Fonterra upon exit. It would also encourage new or expanding farmers to switch
or increase their milk supply to Fonterra, as they could buy into Fonterra at a significantly lower
cost and without contributing the full fair value of their investment in Fonterra’s underlying
business. Without an adequate reference pressure on their shareholding investment-based
returns this could skew Fonterra’s business investment decisions towards activities that
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 3maximise returns on milk supply and away from product development and other value-add
activities.
Fonterra has sought an amendment to the DIRA to support its implementation of the new
capital structure
13. Under TAF, the unit Fund is a key mechanism for enabling liquidity in the market for Fonterra’s
shares and helping to discover the full fair value of those shares. As part of its new capital
structure, Fonterra wishes to partially delink the unit Fund on a permanent basis. This could
expose Fonterra to legal action. Fonterra has therefore sought an amendment to the DIRA to
remove risk that legal action could be taken against it under DIRA. Section 109M of the DIRA
prohibits Fonterra from restricting the exchange of shares for units if that is done (among other
things) “for the purpose of restricting, preventing or deterring” a shareholder farmer from
ceasing or reducing the supply of milk to Fonterra.3
Benefits and risks of Fonterra’s proposed new capital structure
14. A well-functioning dairy industry is of significant national interest, particularly while our
economy recovers from the impacts of COVID-19 and wider economic and geo-political
disruption.
15. The dairy industry is one of New Zealand’s largest export revenue earners. Around 95 percent
of all farmers’ milk produced in New Zealand is exported, with export revenues of
approximately $19.1 billion a year. It accounts for 35 percent of total merchandise exports and
around 3.1 percent of GDP. The industry employs around 49,000 workers, bringing
considerable benefits to New Zealand’s rural communities.
16. A sustainable, high-performing Fonterra underpins a well-functioning dairy industry. Fonterra is
New Zealand’s largest company, with significant global scale and reach. It has around 10,000
farmer-shareholders, and currently collects 79 percent of all milk produced in New Zealand,
which it exports to more than 130 countries worldwide. Given its size, Fonterra’s successes
and any opportunity costs of unrealised potential are not only borne by its farmer-shareholders,
but also by rural communities and the wider New Zealand economy.
17. Fonterra’s capital restructuring offers benefits to the co-operative and to farmers, with flow-on
benefits to rural communities and the wider New Zealand economy. The proposed capital
restructure will lower the cost of entry for farmers wishing to join the co-operative and supply
milk to Fonterra, thus enabling Fonterra to retain and attract milk supply in the face of forecast
plateauing or declining milk production in New Zealand. This in turn will enable Fonterra to
make efficient use of sunk investment in processing facilities, remain a large-scale, New
Zealand farmer-owned co-operative, and to allocate capital to investments in innovation and
sustainability4.
18. The reduced minimum shareholding requirement could also enable farmers to free up some
capital, which farmers could use to repay on-farm debt or invest in on-farm innovation,
including to advance environmental and/or climate change mitigations.
19. However, Fonterra’s capital restructuring also creates long-term risks and potential flow-on
impacts, which could be detrimental to farmers, the diversity and contestability of the whole
dairy industry, Fonterra’s long-term performance, and the wider New Zealand economy. These
include:
3
Section 109M also restricts this type of behaviour for the purposes of restricting, preventing, or deterring farmers from becoming
shareholding farmers; or shareholding farmers from increasing their volume of milk supplied to Fonterra. See section 109M for full text
(https://www.legislation.govt.nz/act/public/2001/0051/latest/DLM4639278.html).
4
Fonterra intends to invest around $1 billion in upgrading its transport and manufacturing assets to decarbonise their footprint and
improve water use and quality (fonterra-2021-long-term-aspirations-booklet.pdf).
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 4• Impacts on the contestability of milk supply. The capital restructuring involves a restricted
farmers-only share market and a supressed share price, with associated liquidity issues.
Farmers wishing to retire, invest in alternative land use or other productive activity, or
supply another dairy processor could be constrained or deterred from exiting Fonterra, if
they cannot realise the full value of their capital investment in the co-operative on exit. This
in turn could impact on competing dairy processors or constrain new entry. The dairy sector
and economy could therefore forego future diversity and innovation in the dairy sector.
Fonterra could also face less competitive pressure from potentially more innovative or
efficient processors, resulting in reduced incentive to perform optimally over time.
• The establishment of a restricted farmers-only share market will see a supressed share
price. This could artificially increase the attractiveness of Fonterra shares to new or
expanding dairy farmers, as a structurally lower share price at the same dividend would
artificially inflate the rate of return on shareholding in Fonterra. Fonterra might, as a result,
collect and process higher than economically efficient volumes of milk, while avoiding or
deferring the decommissioning or reconfiguring of some of its existing commodity
processing capacity. This could reduce pressure on Fonterra to continuously seek to
optimise its size and product mix and invest in innovation and value creation.
• Higher prices for farmers’ milk could flow through to New Zealand consumers. Since the
vast majority of domestic consumer dairy products are manufactured using Fonterra’s milk,
any increase in Fonterra’s price for farmers’ milk (unless absorbed by Fonterra) would
represent a cost increase to the manufacturers of domestic dairy products. This would be
one of a number of factors across the domestic supply chain that affects consumer prices,
making it difficult to assess the likelihood and magnitude of this potential flow-on impact.
• Value will be eroded for unit holders in the unit Fund: the retention of a partially delinked
unit Fund means that the Fund may reduce in size but cannot grow.5 Fonterra’s decision
not to buy out the unit Fund at this time and to allocate its capital to other priorities may
undermine investor confidence in Fonterra and, given that Fonterra is New Zealand’s
largest company, in New Zealand as a place to invest.
Government response
20. Cabinet has agreed to support Fonterra’s capital restructuring and amend the DIRA to
specifically enable the unit Fund to remain partially delinked on a permanent basis.
21. Other options were considered and are set out in MPI’s Regulatory Impact Statement,
including:
• Leaving Fonterra to proceed with its capital restructuring but not making any enabling
amendments. This may, however, have left Fonterra exposed to legal risk.
• Amending the DIRA to regulate more extensively, for example, by introducing stronger and
more direct controls on Fonterra’s milk price-setting processes or on the setting of
dividends and/or retentions. Cabinet considered that this would impose undue constraint on
Fonterra’s ability to make commercial decisions. Such regulation is also highly difficult to
design and costly to implement.
• Deferring any amendments to the DIRA until the next statutory review of the DIRA is
undertaken. This review is required to commence between June 2025 and June 2027.
Cabinet considered that this would involve undue delay, create uncertainty for farmers and
5 Fonterra indicated that if, at some point in the future, it was to issue bonus shares in lieu of a dividend, this would increase the number
of units in the unit Fund. This is because existing units will continue to be entitled to the dividend, which in this case will be in the form of
additional units.
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 5might constrain Fonterra from proceeding with changes that will support its business
strategy.
22. Cabinet decided against these options because Fonterra’s performance is crucial during the
current environment of declining domestic milk supply, growing international competition, and
wider economic and geo-political disruptions.
23. Cabinet has recognised that supporting Fonterra’s capital restructure could reduce
contestability for farmers’ milk supply and weaken incentives on Fonterra to drive long-term
performance, innovation, sustainability, and value creation for the wider dairy industry. Cabinet
therefore agreed that existing DIRA regulatory settings should be strengthened to reduce these
risks and the measures outlined below have been identified as a package to be tested with
stakeholders and developed further ahead of the legislative amendments being progressed in
Parliament.
Amendments to strengthen the base milk price-setting regime
24. Fonterra’s base milk price-setting processes were developed by Fonterra as an internal
management tool. Fonterra’s base milk price-setting was embedded in the DIRA in 2012 to
provide farmers with more transparency about Fonterra’s performance. The DIRA sets out
provisions relating to the calculation of the base milk price that a notionally efficient processor
of Fonterra’s size and scale, manufacturing only commodity dairy products and selling them in
global markets, could pay its suppliers in the short term, after costs have been deducted.
25. Transparency in Fonterra’s base milk price setting processes is important, as Fonterra’s
dominance in the market for farmers’ milk means that Fonterra essentially sets the price for the
whole dairy industry. To attract and retain farmers’ milk supply, other processors need to match
or exceed Fonterra’s farm gate milk price.
26. This creates incentives on other processors to be as efficient as possible, in order to be able to
compete for milk supply. However, Fonterra could have an increased ability to set an artificially
high milk price, thus imposing costs on competitors and constraining competition. The
measures in the DIRA are therefore established to promote more transparency and confidence
in Fonterra’s milk price being consistent with contestable market outcomes. They do not
regulate the price that Fonterra actually pays to farmers for milk.
27. Cabinet has proposed the following amendments to increase the degree of independence of
Fonterra’s internal milk price-setting processes:
1. Increase the number of Ministerial nominees to the Milk Price Panel from one to two
and ensure that their proportional contribution to Panel’s recommendations to the
Fonterra Board cannot be diluted by prescribing both the maximum (seven) and
minimum (five) number of Panel members.
AND
2. Require that the Chair of the Milk Price Panel:
• must be suitably independent of Fonterra
• can only be appointed by the Fonterra Board with the Minister’s approval
• is additional to the two Ministerial nominees on the Panel.
AND
3. Require Fonterra to contract out the day-to-day administration of the base milk price
calculation to an external party; and replace the contracted party every 4-6 years.
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 628. The DIRA already allows for one ministerial nominee on the Milk Price Panel (the Panel). The
proposed amendment would allow for two Ministerial nominees. The terms and conditions for
the appointment and conduct of the additional Panel member would be the same as for the
existing Ministerial nominee. Fonterra’s Board is responsible for appointing the Ministerial
nominee and that person is subject to the Terms of Reference set by the Board and applicable
to all Panel members.
29. To ensure that the Ministerial nominees’ proportional contribution to the Panel’s decisions
cannot be diluted, the total number of Panel members would be prescribed in the DIRA at
seven. The Panel currently comprises five members. The quorum would be set at five,
including at least one Ministerial nominee.
Questions: 1. What impact do you consider this measure might have on your
business?
2. What criteria do you consider that the Minister should take into account
when selecting his/her nominees?
3. What criteria do you consider Fonterra should be required to take into
account when selecting the external party to administer the base milk
price calculation?
30. Under Fonterra’s current terms of reference for the Milk Price Panel, the Chair is appointed by
the Board and must be one of the two Fonterra directors appointed to the Panel by the
Fonterra Board. The proposed amendment would require that the proposed Chair is approved
by the Minister before being appointed by Fonterra’s Board; that the person be suitably
independent of Fonterra (for example, not connected to a shareholding farmer, or an
employee, director, an agent or an associate of Fonterra or its Co-operative Council); and is
additional to the two Ministerial nominees on the Panel.
Questions: 4. What impact do you consider this measure might have on your
business?
5. What criteria do you consider that the Minister should take into account
when approving the Chair?
6. How do you consider the Chair’s ‘independence’ should be provided for
in the DIRA?6
31. An amendment to require Fonterra to contract out the day-to-day administration of the
base milk price Manual and calculation would embed and improve Fonterra’s current
practice in law. Fonterra already contracts external expertise to undertake this function,
although it does not as a matter of course change the contracted party on a regular basis. The
amendment would require the external party to operate at arms-length from Fonterra
management and Board, and be rotated every four to six years. The criteria for selecting and
appointing the external party would be specified in the DIRA and be similar to the criteria for
selecting and appointing external auditors. This may improve confidence in Fonterra’s internal
milk price-setting processes.
Questions: 7. What impact do you consider this measure might have on your
business?
6
The current definition in the DIRA is: independent, in relation to a person, means that the person is none of the following:
(a) a shareholding farmer:
(b) a relative of a shareholding farmer:
(c) an employee of new co-op:
(d) an employee of a shareholding farmer:
(e) a person who has a direct or indirect financial interest in a farm that supplies milk to new co-op:
(f) a person who has a relevant interest in new co-op fund securities
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 78. What criteria do you consider should be included in the DIRA for
selecting and appointing the external party?
32. Amendments are also proposed to provide stronger direction to Fonterra on how it
calculates its base milk price, which serves as a transparent reference point for the Fonterra
Board’s farm gate milk pricing decisions. Cabinet agreed to:
4. Reduce Fonterra’s discretion in setting the base milk price by giving the Commerce
Commission the power to make its review findings binding on Fonterra’s inputs,
assumptions, and processes in the base milk price Manual and the calculation.
33. This measure would require amendments to the DIRA to give the Commerce Commission
limited powers of direction on inputs, assumptions and processes used by Fonterra in its base
milk price Manual and calculation. Currently, the Commerce Commission is able only to
monitor and question but cannot require Fonterra to act on its findings. The proposed powers
would not extend to direction of either the quantum of the calculated base milk price or the
actual farm gate milk price paid by Fonterra to farmers. The following table sets out indicative
detail on the proposed powers.
Nature of The Commission could be able to direct Fonterra to:
proposed powers • adopt, amend, or comply with the Commission’s views to setting
all or some inputs, assumptions, and processes in the base milk
price Manual and calculation for the season,
• notify the Commission of any amendments Fonterra has made or
plans to make to the inputs, assumptions, and processes in the
base milk price Manual and calculation for the season,
• obtain the Commission’s approval before making any material7
amendments to the inputs, assumptions, and processes in the
base milk price Manual and calculation for the season, and
• publish certain (not commercially sensitive) base milk price
Manual- and calculation-related information.
Criteria for The Commission could use its powers to direct Fonterra on the
exercising specific assumptions, inputs, and processes that the Commission
proposing powers considers would be consistent with the s 150A purpose of Subpart 5A
of the DIRA.
Process and Before giving a direction, the Commission could be required to consult
timing for Fonterra on the proposed direction, and the Commission’s reasons for
exercising considering issuing the proposed direction. The Commission could
proposed powers then be required to consider Fonterra’s submission before finalising
the direction. The Commission’s direction could be amended or
revoked at Commission’s volition, the process for which would be
similar to the process for making the direction.
The statutory deadlines would therefore need to be substantially
altered if the directions were to take effect in the year that they are
made. Alternatively, if the statutory timelines were kept substantially
the same, the directions could be made following the Commission’s
final report and take effect the following year.
Consideration would need to be given to the timing of any direction
made and the relevant season they would apply to. The current
7 The definition of ‘materiality’ would need to be provided for in the DIRA.
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 8statutory deadlines for the Manual and calculation reviews do not
allow for the direction to be proposed, consulted on as part of the draft
report, and made in time for the final report. The statutory deadlines
would therefore need to be substantially altered if the directions were
to take effect for the dairy season that they are made. Alternatively, if
the statutory timelines were kept substantially the same, the directions
could be made following the Commission’s final Manual or calculation
reports and take effect the following year.
Additional consideration may also need to be given to the timing of
Fonterra’s internal milk price-setting processes, how they correspond
and relate to the Commission’s statutory timeframes, and whether
additional clarity and/or guidance could be warranted (e.g., around the
timing for the Milk Price Panel’s recommendation to the Fonterra
Board) to avoid confusion.
Form of proposed The Commission could give the direction by issuing a direction notice,
powers as part of, or following, its annual final reports on the base milk price
Manual and calculation. The notice could include the Commission’s
reasoning for its direction.
Checks and Fonterra could be able to request that Commission amends or
balances on revokes a previous direction. Provided Fonterra supplied sufficient
exercise of evidence and/or mounted a reasonable case for any such amendment
proposed powers or revocation, the Commission could be required to consider the
request.
The Commission’s exercise of its powers to direct could be subject to
judicial review only. This may be justified on the basis that the powers
to direct would only apply to the inputs, processes, and assumptions
informing the base milk price Manual and calculation, not the quantum
of the calculated base milk price and not the quantum of the farm gate
milk price that the Fonterra Board subsequently sets.
Penalty for The DIRA’s standard penalty provision for contraventions is a fine not
contravening exceeding $200,000 and a fine of $10,000 for each day that the
directions offence continues. Consideration will need to be given as to whether
this level of penalties should be retained or increased to more closely
align with other similar regulatory regimes’ penalties, including:
• the Retail Payment System Bill, which provides for penalties for
contravention of a direction of up to $2 million;
• Part 4 of the Commerce Act, which provides for penalties for
breaches of price-quality requirements of up to $5 million; and
• the Fuel Industry Act, which provides for penalties of up to $5
million.
Questions: 9. What matters do you consider should be included in any powers of
direction given to the Commerce Commission?
10. What changes to the statutory deadlines for the Commerce
Commission’s review processes and/or Fonterra’s internal milk price
setting processes would you consider necessary to ensure effective
operation of the existing monitoring regime and the proposed powers?
Please give reasons for your view.
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 9Amendments to support liquidity in the farmers-only market
34. There are two amendments that aim to minimise the potential liquidity discount that could arise
in the farmers-only market for Fonterra shares from time to time:
5. Require a market maker to maintain a range of minimum bid/ask spreads in the
market. This measure would also comprise: a scaled obligation on the market maker to
participate as liquidity changes; an obligation to hold a minimum amount of inventory;
and the ability to hold additional inventory for long periods of time to facilitate liquidity
in the market.
AND
6. Require Fonterra to ensure independent financial markets (e.g. broker or other)
research and analysis of Fonterra’s performance are easily accessible to farmers.
35. Even at sufficient levels of liquidity the farmers-only market would still produce a structural
restricted-market discount (which would arise from having an undiversified pool of shareholders
exposed to the same economic drivers). The proposed liquidity-support measures in the DIRA
would therefore aim to limit the extent to which Fonterra’s share price reflects only the
restricted market discount, rather than attempt to eliminate it.
36. Fonterra’s farmers-only market design envisages liquidity in the farmers-only market to
continue to be supported by the function of a market maker. Left unregulated, the nature and
extent of the market-maker’s liquidity support would continue to be provided for in its
contractual arrangements with Fonterra and be determined as a matter of company policy by
the Fonterra Board, changing from time to time in response to changing share market
dynamics.
37. However, these contractual arrangements would be materially different from those currently in
place. This is because the market maker’s ability to protect its balance sheet exposure to share
price volatility by converting shares into units and vice versa would no longer exist under
Fonterra’s new capital structure. The market maker should therefore be incentivised to rely on
Fonterra’s balance sheet for the additional risk management. Fonterra, on the other hand,
would be incentivised to minimise its balance sheet exposure. As a result of these conflicting
incentives, the liquidity support in the farmers-only market may not always be adequate.
38. Potential amendments regarding the market maker would set out broad expectations, rather
than prescriptive requirements. This would reflect the need to strike a balance in legislation
between providing more assurance on liquidity, without removing the flexibility for Fonterra to
respond to changing market conditions.
Question: 11. How do you consider the requirements regarding the functions of the
market maker could best be set out, noting the intention to avoid highly
prescriptive requirements?
39. Potential legislative amendments to ensure independent financial markets (e.g., broker or
other) research and analysis of Fonterra’s performance are easily accessible to farmers
would aim to see farmers, who are trading in a restricted market, better informed on Fonterra’s
performance by independent sources. Fonterra’s TAF capital structure ensured financial
markets commentary, analysis, and scrutiny of Fonterra’s financial performance because the
unit Fund was publicly listed and therefore subject to various financial market rules, disclosure
obligations. The proposed transparency measure above offers an alternative to the TAF-related
feedback.
Question: 12. Would this measure have an effect on you own business? If so, how?
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 10Amendment concerning dividend and retentions policy
40. As discussed above, the establishment of a farmers-only share market will see a substantially
lower share price. This could artificially increase the attractiveness of Fonterra shares to new or
expanding dairy farmers, as a structurally lower share price at the same dividend would
artificially inflate the rate of return on shareholding in Fonterra. This could have flow-on effects.
Fonterra would have the ability to pay a higher than efficient milk price, as it could leverage an
inflated dividend yield to shift some of its capital returns from the dividend to the milk price. This
could impact on the contestability of milk supply.
41. In addition, Fonterra’s ability to retain sufficient levels of internal capital could be reduced, due
to a risk of diverging interests between those shareholders who hold the minimum number of
shares to supply milk (who would wish to see the milk price maximised), and those who hold
larger numbers of shares for investment purposes (who would also want to see higher returns
on investment through dividends). If there is shareholder pressure to pay both a high milk price
and a high dividend, this could result in Fonterra generating insufficient internal capital.
42. The following measure is therefore proposed:
7. Require Fonterra to maintain and publish a dividend and retentions policy
43. Fonterra currently maintains a set of dividend policy guidelines8. Under these guidelines, the
Fonterra Board expects over time to distribute 50 percent of the co-operative’s net earnings,
excluding abnormal gains, as dividends. However, the Board applies these guidelines at its
discretion, alongside any other factors it considers relevant. The DIRA would be amended to
include a requirement for Fonterra to maintain and publish a dividend and retentions policy.
This would not include any statutory requirement or direction on the scope of that policy but
would embed in legislation what Fonterra already does.
44. This measure aims to embed sound practice and transparency, while leaving Fonterra with the
commercial flexibility it needs to run a business. Cabinet considered whether to implement a
more prescriptive regulatory approach that might define specific levels of retentions and
dividends.
Question: 13. What effect, if any, do you consider this measure could have on
your business and/or the dairy sector as a whole? Please provide
reasons for your view.
Next steps
45. Following receipt of submissions, officials will advise the Minister of Agriculture of the outcome
of consultation and undertake more detailed work on the regulatory design and implementation
of the measures outlined above, for inclusion in a Dairy Industry Restructuring Amendment Bill
to be introduced and progressed through Parliament in 2022.
46. The Bill would be subject to a Select Committee process that normally provides a further
opportunity for all interested parties to engage on the legislation.
8
Dividends (fonterra.com)
Ministry for Primary Industries Government Response to Fonterra’s Capital Restructuring Discussion Document • 11You can also read
